During business-cycle expansions, wages appear to rise relative to output prices. This fact is easy to square with real business-cycle models which are based on the assumption that labor is more productive during expansions. But it is inconsistent with standard business cycle theories based on aggregate demand fluctuations. In these models, fixed technology and diminishing returns imply that labor becomes less productive as output rises. Thus, in an expansion, wages should fall relative to output prices. Liquidity constrained firms should raise markups, cut capital expenditures and cut inventories during cyclical downturns. Markups tend to be more counter-cyclical in industries that have a greater proportion of liquidity-constrained firms, Of course, these results should be interpreted cautiously for several reasons: they depend on comparisons across industries; they rely on highly aggregated measures of industries; and the validity of the markup measure is difficult to assess. An alternative approach is to examine the pricing behavior of firms within particular, narrowly defined, industries.
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